The Failure Of Cable Deregulation

The problem: Deregulation of the cable industry has failed
The Telecommunications Act of 1996 restructured the entire telecommunications industry and left virtually all cable subscribers without protection from unrestricted rate hikes. Since the Act was signed into law, cable rates have skyrocketed; service levels have declined; cable concentration has heavily increased; vertical integration between critical programming developers and cable distributors has gone unabated; wireline cable competitors have faced enormous obstacles going head-to-head with cable incumbents; incumbent cable operators have effectively exploited statutory loopholes in order to deny vital programming content to emerging competitors; and the cable industry now also dominates the broadband residential high-speed Internet market.

Cable Rate Hikes Persist

Since enactment of the 1996 Act that deregulated cable rates, consumer cable prices have been rising at three times the rate of inflation and even faster for basic and expanded basic service, which is the choice of the overwhelming majority of cable subscribers. These rates have risen by more than 50 percent.

Individual markets have suffered much larger increases. For example, New York consumers have been particularly hard hit. In the few years since enactment of the 1996 Act, New York City cable subscribers have seen their bills for the most popular programming tier soar. Cablevision customers in New York City have experienced a cumulative increase of 93.7 percent - nearly doubling monthly bills. Even on the "low" end, Staten Island Cable customers have seen their bills rise 52.5 percent.

Cable price increases have been restrained by competition only when a wireline competitor, often referred to as an overbuilder, enters a market to challenge the incumbent. Where such overbuilder competition exists, the effect is dramatic: The General Accounting Office (GAO) reports that cable rates are 17 percent lower where there is an overbuilder in a franchise area. By contrast, national competition from satellite providers - notwithstanding their increasing market share - has not resulted in lower cable rates.

Although cable operators argue that they face serious competition from the nation's two Direct Broadcast Satellite (DBS) providers, data compiled by the Federal Communications Commission (FCC) also confirm that DBS, while growing in subscribers, appeals primarily to limited subsets of consumers, and is unable to restrain cable's prices charged to consumers at large. Wireline competitors have proven effective at forcing cable operators to restrain their prices, but these competitors have entered only a very limited number of markets, due in large part to cable's concerted anti-competitive efforts to keep them at bay.

With near universality, cable operators have blamed their skyrocketing rates on increases in their programming costs, despite the fact that the principal cable operators receive the most favorable pricing from programmers vis-à-vis overbuilders and satellite providers. Most importantly, augmented advertising revenues and revenues from new services more than cover any programming cost increases. Moreover, 40 percent of the top cable channels - which command the highest prices - are owned in whole or in part by cable operators themselves or by companies with large ownership interests in cable operators.

According to FCC data, price increases have occurred even on a per-channel basis, which proves that cable's "more channels" argument is simply wrong. The cable industry's "better programming" argument is equally implausible. A number of major cable operators have clearly pushed things in exactly the opposite direction by moving very popular channels off the lower tiers of service and on to the higher tiers, extending the cable strategy of bundling services to "drive consumers to buy bigger and bigger packages of programs at higher prices."

One way to raise prices is to do so directly; another way is to allow service quality to deteriorate. Cable companies have done both. When it comes to customer service, the cable industry has one of the worst track records of any service industry in the country. The latest American Customer Satisfaction Index - an annual survey by one of the nation's leading business schools - found that some of the largest cable companies "now rank among the worst rated businesses in the history of the ACSI."

In reality, ever-escalating consumer rates have flowed profitably to the cable industry's bottom line. The industry-wide operating margin is anticipated to be nearly $19 billion for 2002, up nearly 60 percent from 1997. And operating revenues per subscriber have commensurately jumped to $273 per year in 2002 from $190 in 1996. For the industry's largest player, Comcast, this has meant a nearly 36 percent increase in operating cash flow (to $1.597 billion) and operating cash flow margins - "profits" to most people - have reached 36.5 percent in the second quarter of 2003 despite a stagnant national economy and a depressed communications market.

The Cable Monopoly Continues

One reason for all the rate hikes that is supported by the facts is the rapid consolidation of the cable industry. These unabated rate increases reflect cable's enduring dominance in the multichannel video programming market. The FCC's most recent video competition report found that cable continues to corner the consumer market, controlling more than three-quarters of all subscribers to multichannel video services. The number of cable subscribers has increased in each of the last 25 years and now stands at approximately 72 million - more than three and one-half times as many as cable's closest rival, DBS.

The 10 largest cable operators serve about 85 percent of all cable subscribers. And the three largest cable operators - Comcast, Time Warner and Charter - together serve approximately 56 percent of all cable subscribers, up from 48 percent in 1996. Consolidation in the cable industry has been justified on the grounds that bigger companies would operate more efficiently and incur lower costs, which would translate into lower rates.

However, industry consolidation has not led to cost savings for consumers. Comparing rates across small and large cable systems, the FCC expected "to find lower average monthly rates due to increasing economies of scale." But it found just the opposite - the larger the cable company and the greater the dominance of a region through clustering of systems, the higher its rates.

DBS is widespread, has attracted millions of subscribers and may hold future promise to be a more serious competitor to cable. As the FCC's data show, however, DBS is not providing effective competition to cable in the most important segments of the market. Rather, even in areas where DBS has achieved significant penetration, "there is no measurable effect on . . . the price of cable service." Even the cable industry's own economic experts have acknowledged that "[t]he demand for cable is rather insensitive to . . . the DBS price," which "indicate[s] that DBS is not a particularly good substitute for cable in the minds of consumers." Indeed, cable prices have continued to rise steadily over the last decade, even as DBS penetration has risen and its prices have fallen.

This failure of DBS to restrain cable prices also reflects the fact that DBS is popular primarily at two edges of the market - in rural areas where there is no cable service at all, and among the minority of consumers that are willing to pay stiff premiums to receive large numbers of sports channels. DBS also has serious shortcomings that limit its appeal to many cable subscribers. DBS cannot reach many urban customers who lack a direct line of sight to the southern sky, and dishes are often difficult to install in the multifamily dwelling units that house approximately 30 percent of the U.S. population. DBS is still not able to offer local broadcast channels in many markets. Surveys indicate that 47 percent of cable subscribers would not subscribe to satellite service for that reason alone. DBS is also unable to offer customers the same bundles as cable operators, including telephone services, and has been extremely slow in offering efficient two-way high-speed Internet access services. Making matters worse, as the major cable operators have completed their nationwide upgrades to digital facilities, DBS loses the quality advantage it previously could offer to lure high-end subscribers.

Thwarting Competition

Cable operators have the incentive and ability to thwart competition in several respects. As FCC reports show, "where permitted, vertically integrated programmers will use foreclosure of programming to provide a competitive edge to their affiliated cable operators." For example, they continue to deny competing video distributors access to terrestrially (land- based) delivered programming that they own and control, exploiting loopholes in a federal law originally designed to prohibit such anti-competitive conduct. Not only do they own 40 percent of the most popular programming, but of the top 26 channels in terms of subscriber and prime-time ratings, all but one (the Weather Channel) is affiliated with either a principal cable operator or a broadcast network and eighty-six percent of "must have" regional sports programming is also vertically integrated.

The cable incumbents refuse, or create obstacles, to carry a large amount of programming that is owned or controlled by their competitors. And these operators aggressively attempt to deny competitively vital independent programming to new market entrants through the use of programming contracts, cable-owned content distribution networks and exclusive agreements for equipment, software or other technology.

Cable's emerging competitors are facing increasing difficulty in obtaining access to cable-owned programming. In New York, for example, Cablevision obtained control of seven of the nine local professional sports teams and still denied an overbuilder, RCN, access even to the overflow programming (games not featured on Cablevision's Madison Square Garden network) when more than one of the seven teams is playing simultaneously. By contrast, Cablevision did give RCN access to the same sports channels for distribution in those parts of New Jersey where Cablevision is not the dominant provider of cable service.

The recent battle between Cablevision and the YES Network over carriage of Yankee baseball games in the New York metropolitan area is a glaring example of how large incumbent cable operators can and do exercise enormous leverage over new and competing content providers, to the detriment of consumers. Using the impetus of the recent Cablevision-YES dispute in New York, at least one cable incumbent is proposing that Congress allow it to coercively "re-tier" programming that it does not control, particularly sports programming. For example, such a proposal would prohibit programmers from negotiating the carriage of their programming on a specific tier. This proposal does nothing to advance consumer interests, will not reduce cable prices and only benefits cable operators in their bargaining with programmers. The incumbent cable company could favor affiliated programming by placing it on a "preferred tier" at the expense of competing programming.

Cable operators enter into agreements with unaffiliated programming providers with the effect of creating exclusive rights to deliver the programmer's content. Cable operators are now adapting that practice to lucrative video-on-demand (VOD) services. A number of major cable operators have formed a consortium called in DEMAND that obtains VOD content from the major Hollywood studios, as well as other attractive programming content (such as sporting events), which is then made available exclusively to the cable operators' own subscribers. Cable operators are also denying potential competitors access to VOD content indirectly by forming exclusive agreements with equipment suppliers that expressly deny rivals the technology (equipment, software, etc.) necessary to deliver VOD programming.
Cable operators have successfully undermined the leased-access provision of the cable act. Federal law requires cable operators to set aside up to 15 percent of their channel capacity so that unaffiliated programmers may offer competing service packages to consumers. As Congress envisioned it, the purpose of this requirement "is to promote competition in the delivery of diverse sources of video programming and to assure that the widest possible diversity of information sources are made available to the public." Instead the FCC, with the support of the cable industry, has successfully undermined this mandate by adopting a pricing methodology that sanctions a per channel rate that no competing programmer could pay and still remain commercially viable.

Extending the Anticompetitive Model to the Internet

Cable operators now also dominate the broadband Internet market, comprising a huge new source of profits. Cable now has nearly twice as many subscribers as its nearest broadband competitor, DSL (digital subscriber line). Comcast, the largest cable operator in the nation, has become the largest provider of broadband services, adding 350,900 subscribers in the second quarter of 2003 for a total of approximately 4.4 million subscribers, with its revenue from these services increasing 56.6 percent (to $548 million) over second quarter 2002.

As the largest providers of broadband Internet service, cable operators have become a critical link in the public's ability to participate in the Internet's growing virtual "town square" of American discourse and civic activities. The danger that cable's reign poses to the diversity and democracy of the Internet is quite simple: Cable operators are not required to share their networks with competitive Internet service providers (ISP's). Independent ISP's will not be able to provide cable broadband Internet services because they will not have access to cable wires, unless cable operators open their wires and networks to competitors. They will either have to provide DSL reseller service from phone companies or attempt to negotiate access with a cable operator, which is at the discretion of such operators.

Cable operators have taken anti-competitive action to limit access to certain streaming video content to prevent or limit broadcast quality streaming video over their broadband Internet cable modem service as a means of blocking current and future competition for video content. This has created significant concern on behalf of many of the Internet's leading content providers and e-commerce websites. Some cable operators have also apparently opted to condition the carriage of a video channel upon the provider's agreement not to distribute the same content over the Internet at all.

The Solution: Move Decision Making Out Of Washington, Give Consumers Real Choices And Create Conditions That Give Competition A Chance

Since its inception and growth throughout the second half of the 20th century, cable television service has brought an enormous amount of popular news and entertainment programming into the living rooms of America. The cable industry has used public rights of ways to access those homes and in turn made huge profits. This report makes clear that the cable industry has not lived up to its public and civic responsibilities as holders of valuable public franchises and licenses. Congress, the FCC, and state and local governments must examine the recommendations made in this report and take appropriate action to restore competition to the multichannel video market. Fortunately, the harmful effects of cable deregulation are not insurmountable. Consumers could still reap the benefits of the 1996 Act's pro-competitive intent through a new model. The building blocks of a truly pro-competitive model are as follows:

Congress must empower state public utility commissions (PUC) to regulate all cable rates and charges for video services until meaningful competition emerges. Congress should grant state public utility commissions the authority to regulate all cable rates and charges and to combat anti-competitive predatory-pricing business practices. With the 1996 Act's deregulation, rates for the cable programming tier to which the vast majority of consumers subscribe have inflated without restraint. Consumer rate protections at the state level are needed, but state PUC rate regulation is only necessary and desirable until robust competition that actually disciplines cable prices emerges.

Return authority to local communities. Preemptive provisions of the Act have thwarted attempts by local communities to protect cable subscribers from the worst of the industry's depredations. These preemptive provisions must be abolished so that policy control may be returned to community leaders who are closest to consumers and who are most committed to ensuring that their communities have access to multiple providers of competitively priced video services.

Introduce à la carte programming requirement to expand consumer choices. Consumers should be able to choose their own suite of programming, rather than being force-fed the programming tiers that cable operator want them to purchase. Consumers must be given the right to purchase every individual channel on an Ã¡ la carte basis at fair, reasonable and nondiscriminatory prices.

Adopt reasonably priced leased-access rates. Cable operators have avoided their obligation to lease channel capacity to independent programmers by setting the prices so high that no competing provider could possibly pay current fees and remain commercially viable. In order to promote competition with diverse and independent programming, reasonably priced leased access must be adopted. This pro-competitive pricing should be based upon the FCC's existing rate-setting methodology, which was designed to promote competition in the telecommunications market.

Ensure consumer input with a public board member. A public member representing subscribers should be placed on the board of directors of any cable operator with a greater than four percent market share of cable households as a condition of franchise or FCC approval. Such a public member should have no current or prior affiliation with a cable, broadcast or DBS distributor or programmer, or any of their industry trade associations, and should be barred from joining such a board as a public member for five years after serving in any such affiliation. Public members should be selected by a committee of outside directors and approved by the shareholders. This would ensure better consumer input and assist in preventing insider dealing and financial mismanagement, as has occurred with some of the nation's leading cable operators.

Empower the viewers and citizens. Citizen-viewers should have a direct voice in the process of cable regulation and the opportunity to use that voice to create their own well-funded news and public affairs channels. When cities negotiate franchise agreements with cable companies, they should require that cable operators include billing inserts that invite consumers to join a local Cable Action Group that would operate a local Audience Channel, well-funded and equipped by the cable company. Such a group would serve a dual purpose: operating the local channel and organizing consumers into a mobilized interest group to advocate for pro-consumer and pro-democracy media policy. Alternatively, local or state governments could assist in fundraising for the Cable Action Group, by collecting membership dues through inserts in tax or license renewal mailings. Illinois Citizen Utility Board (CUB) is funded in this manner and represents the interests of Illinois gas, electric, phone and other utility ratepayers.

Ensure access to vital programming. Newly formed competitors cannot survive, let alone thrive, if cable operators are allowed to continue their anti-competitive practices of locking up must-have programming, such as sports and other regional channels. The existing federal program-access law must be modified to eliminate loopholes that have allowed the cable industry to continue these anti-competitive practices and undermine the emergence of wireline competitors. Additionally, cable operators should be prohibited from entering into exclusive contracts for equipment or other technical services that prevent competitor access to such programming.

Prohibit cable broadband content restrictions to allow consumers full use of the Internet. Cable operators have a long history of restricting consumer access to content that cable operators disfavor. With the cable industry's ongoing dominance of the broadband market, cable operators must be prohibited from restricting consumer access to Internet content based on the source or nature of the consumer's request.